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Irreversibility and Optimal Timing of Climate Policy

We focus on the optimal timing of climate change mitigation policies, a decision which is complicated by multiple sources of irreversibility or inertia. The pertinence of Real Option Theory in understanding the optimal amount of necessary precautionary behavior is explored, as are the results from modeling exercises. Generally, it appears that irreversibility associated with sunk abatement capital is stronger than that from accumulating greenhouse gas emissions, implying an "option value" to delaying climate change mitigation. The inclusion of tipping points, or non-linearities in environmental damages, could nevertheless lead to the opposite conclusion. These effects are however not easily quantifiable and are not generally included in modeling exercises. The timing decision will therefore have to be made by policy makers after having subjectively evaluated the importance of potential tipping points. It is for this reason that policy-makers need to be able to themselves understand the intuition behind Real Option theory - the interplay between irreversibility and uncertainty. Many climate-economic modeling exercises have implicitly recognized this fact by integrating strict environmental targets which serve as hard constraints and represent precautionary behavior.

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Paper provided by IED Institute for Environmental Decisions, ETH Zurich in its series IED Working paper with number 10-14.

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Length: 26 pages
Date of creation: Dec 2010
Date of revision:
Handle: RePEc:ied:wpsied:10-14
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  1. Astrid Zabel & Karen Pittel & Göran Bostedt & Stefanie Engel, 2009. "Comparing Conventional and New Policy Approaches for Carnivore Conservation – Theoretical Results and Application to Tiger Conservation," IED Working paper 09-06, IED Institute for Environmental Decisions, ETH Zurich.
  2. Moritz Rohling & Markus Ohndorf, 2010. "Prices vs. Quantities with Fiscal Cushioning," IED Working paper 10-11, IED Institute for Environmental Decisions, ETH Zurich.
  3. Robert Finger & Werner Hediger, 2008. "The Application of Robust Regression to a Production Function Comparison – the Example of Swiss Corn," IED Working paper 08-02, IED Institute for Environmental Decisions, ETH Zurich.
  4. Tsur, Yacov & Zemel, Amos, 1996. "Accounting for global warming risks: Resource management under event uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 20(6-7), pages 1289-1305.
  5. Renate Schubert & Julia Blasch & Kristin Hoffmann, 2007. "Environmental Protection, Energy Policy and Poverty Reduction – Synergies of an Integrated Approach," IED Working paper 07-01, IED Institute for Environmental Decisions, ETH Zurich.
  6. Stefanie Engel & Charles Palmer, 2009. "The Complexities of Decentralization in a Globalizing World," IED Working paper 09-08, IED Institute for Environmental Decisions, ETH Zurich.
  7. Astrid Zabel & Brian Roe, 2009. "Performance Payments for Environmental Services : Lessons from Economic Theory on the Strength of Incentives in the Presence of Performance Risk and Performance Measurement Distortion," IED Working paper 09-07, IED Institute for Environmental Decisions, ETH Zurich.
  8. Markus Ohndorf, 2010. "Optimal Monitoring for project-based Emissions Trading Systems under incomplete Enforcement," IED Working paper 10-13, IED Institute for Environmental Decisions, ETH Zurich.
  9. Justin Caron & Markus Ohndorf, 2010. "Irreversibility and Optimal Timing of Climate Policy," IED Working paper 10-14, IED Institute for Environmental Decisions, ETH Zurich.
  10. Julia Blasch & Renate Schubert & Birgit Soete, 2010. "Grün aus der Krise – Was können «grüne» Konjunkturpakete leisten?," IED Working paper 10-10, IED Institute for Environmental Decisions, ETH Zurich.
  11. Stefanie Engel & Charles Palmer, 2008. "“Painting the Forest REDD?” Prospects for Mitigating Climate Change Through Reducing Emissions from Deforestation and Degradation," IED Working paper 08-03, IED Institute for Environmental Decisions, ETH Zurich.
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